APRA releases international capital comparison study

15.18

The Australian Prudential Regulation Authority (APRA) has today released the results of a study comparing the capital position of the Australian major banks against a group of international banking peers.

The study was conducted by APRA in response to Recommendation 1 of the Financial System Inquiry (FSI). The FSI recommended that APRA should ‘set capital standards such that Australian authorised deposit-taking institution [ADI] capital ratios are unquestionably strong’. APRA fully supports this recommendation, as the benefits are clear for the financial system and for the Australian community.

In its final report, the FSI suggested that for banks to be regarded as ‘unquestionably strong’ they should have capital ratios that position them in the top quartile of internationally-active banks. APRA’s study, which adjusts for differences in measurement methodology across jurisdictions and uses a number of different measures of capital strength, found that the Australian major banks are well-capitalised, but not in the top quartile of international peers.

The results of the study will inform, but will not ultimately determine, APRA’s approach for setting ‘unquestionably strong’ capital adequacy requirements. APRA regards the top quartile positioning as a useful ‘sense check’ of the strength of the Australian framework, but does not intend to tightly tie Australian requirements to a benchmark based on the capital adequacy ratios of international banks.

A final response to the determination of ‘unquestionably strong’ capital standards will require further consideration by APRA, taking into account the results of this study, changes arising from the Basel Committee on Banking Supervision’s current review of the global capital adequacy framework, and the extent of further strengthening in the capital ratios of peer international banks. Taking all of these factors into account, APRA’s current judgement is that the major banks would need to increase their capital adequacy ratios by at least 200 basis points, relative to their position in June 2014, to be comfortably positioned in the top quartile of their international peers over the medium- to long-term, as recommended by the FSI.

APRA is committed to ensuring that any strengthening of ADI capital adequacy requirements as a result of the FSI recommendations and the Basel Committee’s deliberations occurs in an orderly manner. Australian ADIs should, provided they take sensible opportunities to accumulate capital, be well placed to accommodate any strengthening to capital adequacy requirements that APRA implements over the next few years.

The study is released as an APRA Information Paper and can be found on APRA’s website.

Background

Q: Why did APRA undertake this study comparing the capital ratios of the Australian major banks with international banks?

A: The study is an initial step in addressing the FSI’s recommendation that APRA should ‘set capital standards such that Australian authorised deposit-taking institution capital ratios are unquestionably strong’. The FSI suggested this should be measured by ensuring Australian ADI capital ratios are in the top quartile relative to international peers. This study helps inform interested parties on the current relative positioning of the Australian major banks, and the likely impact of the FSI’s recommendation.

Q: Given APRA’s submission to the FSI said there was no internationally-harmonised capital ratio that could be used to compare banks, how has APRA been able to make conclusions about international relativities?

A: There is no single internationally-harmonised capital ratio that provides a definitive measure of capital adequacy for the purposes of international comparison. To overcome this, the APRA study (i) makes a range of adjustments to the reported capital ratios of the major banks to make them more consistent with common international supervisory practice, and (ii) uses a number of different measures of capital strength. These allow broad conclusions on the relative position of the Australian major banks to be made.

Q: What were the main findings from the study?

A: The study has three primary conclusions:

• the Australian major banks are well capitalised;
• when reported on a more consistent basis relative to their international peers, their Common Equity Tier 1 capital ratios would be, on average, in the order of 300 basis points higher; and
• on average, and on a comparable basis, the major banks’ capital ratios are above the median, but not in the top quartile, for Common Equity Tier 1 capital. They rank similarly or lower for other measures of capital adequacy.

These findings are consistent with the conclusions reached by the FSI.

Q: How will these findings be used by APRA?

A: The results of the study will inform, but not determine, APRA’s approach for setting capital adequacy requirements. In particular, APRA sees top quartile positioning as a useful ‘sense check’ of the strength of the Australian capital framework against those in other jurisdictions. However, APRA does not intend to tightly tie Australian capital adequacy requirements to a continually moving international benchmark.

Q: What is APRA’s definition of ‘unquestionably strong’?

A: APRA has not settled on a definition and will need to consider further how capital requirements should be adjusted to ensure Australian ADI capital ratios are ‘unquestionably strong’. While APRA has used the 75th percentile (i.e. the bottom of the top quartile) of international peers, this is simply as a benchmark for the purposes of this study.

Q: What will APRA take into account in setting capital standards to achieve ‘unquestionably strong’ ADIs?

A: APRA will take a coordinated approach to strengthening capital adequacy requirements for Australian ADIs that takes into account a range of factors, including the results of this study, international initiatives in the pipeline such as the Basel Committee on Banking Supervision’s current review of the global capital adequacy framework for banks, and the extent of further strengthening of international bank capital ratios.

Q: Will APRA increase ADI capital requirements by 200 basis points?

A: The FSI proposed that for banks to be ‘unquestionably strong’ they should have capital ratios in the top quartile of internationally-active banks. This study helps inform interested parties on the impact of that positioning: APRA’s current view, based on a range of factors, is that to be comfortably positioned in the top quartile of their international peers over the medium- to long-term, as recommended by the FSI, the Australian major banks would need to increase their capital adequacy ratios by at least 200 basis points, relative to their position in June 2014. However, at this point no decision has been made on the total magnitude of any strengthening of capital requirements nor when that strengthening would need to be completed by.

Q: When will any increase start to take place?

A: APRA is committed to ensuring that any strengthening of ADI capital requirements is done in an orderly manner, such that Australian ADIs can manage the impact of any changes without undue disruption to their business plans. APRA will also need to take account of international initiatives still in the pipeline. While it will be possible to move on some aspects of the FSI’s recommendations sooner rather than later, greater clarity on the deliberations of the Basel Committee is unlikely before end-2015.

Q: APRA has previously indicated that it is considering the FSI recommendation regarding risk weights applied by IRB banks to their residential mortgages. How would any change in those risk weights affect this study?

A: To the extent that APRA increases IRB risk weights, and the major banks respond by increasing their actual capital levels to maintain their existing capital ratios, it will improve their position relative to international peers and contribute to closing the gap to the fourth quartile.

Q: Will all Australian ADIs be subject to an increase in capital adequacy requirements?

A: The FSI’s recommendation applied to all ADIs. This study, however, focusses only on the major banks, and the conclusions do not necessarily apply to other ADIs. APRA considers that the impact of future policy adjustments, if any, will in all likelihood be less material for smaller ADIs.

Q: What international banks did APRA use in the study to compare with the Australian major banks?

A: APRA chose to use a sample of 98 large and internationally-active banks that are included in the Basel Committee of Banking Supervision’s most recent Basel III Quantitative Impact Study. These banks, which operate internationally and have at least €3 billion in Tier 1 capital, are domiciled across 21 different jurisdictions.

Q: When will the next study of this kind be undertaken?

A: APRA plans to publish similar capital comparison studies from time to time, but a date for the next study has not yet been determined.